Elon Musk said, “it’s okay to have your eggs in one basket as long as you control what happens to that basket”. This is not only relevant to metaphorical ‘eggs’ but also, perhaps surprisingly, to fixed charges being reclassified as floating charges, as demonstrated in the recent case of Re UKCloud Ltd (in liquidation) [2024] EWHC 1259 (Ch) (24 May 2024).
Nature of fixed and floating charges
As a brief reminder, in the case of National Westminster Bank plc v Spectrum Plus Ltd [2005] UKHL 41 (Spectrum Plus), it was held that a purported fixed charge over book debts paid into an account from which the chargor was able to make withdrawals freely was a floating charge rather than fixed. The court held that, in order for the charge to be fixed, it was necessary for the chargee/lender to demonstrate the requisite level of control over the secured asset (eg by requiring the chargor to obtain consent from the chargee/lender in order to deal with the asset). In terms of what degree of control is required, legal commentary at the time seemed to indicate a total prohibition of all dealings with the charged asset was needed. This was reviewed last year in the case of Avanti Communications Limited (in administration) [2023] EWHC 940 (Ch) (Avanti), where the court took a more nuanced approach to the “total prohibition” view and held that limited opportunities to dispose of the relevant assets in particular circumstances may still be sufficient to constitute a fixed charge, however, complete freedom for the chargor to deal with the charged assets would be unlikely to constitute a fixed charge.
Lender control and consent to deal with the charged assets are not required for floating charges as a floating charge covers a fluctuating pool of assets (eg trading stock or cash in the bank) which will necessarily change over time in the ordinary course of the chargor’s business.
Background
In this recent case, the liquidator of Re UKCloud Ltd (the Company) applied for directions under the Insolvency Act 1986 as to whether a charge over the Company’s internet protocol (IP) addresses contained in a debenture (Debenture) granted by the Company in favour of Harbert Specialty Lending Company II SARL (the Lender) took effect as a fixed or floating charge. There was no express reference to IP addresses in the Debenture, but the agreement did purport to take a fixed charge over “all licences, consents and authorisations (statutory or otherwise) held or required in connection with the Company’s business.”
The Lender argued that this wording created a fixed charge over the IP addresses, which is preferable on a chargor’s insolvency as it would give the Lender priority over those assets (a fixed chargeholder is paid out of the sale proceeds of the fixed charge assets before all other creditors). If the charge was classified as a floating charge, it would rank behind (and would be paid after) fixed chargeholders, expenses of the liquidation and certain preferential creditors. Having clarification on this point was crucial as it would assist the liquidator in fulfilling its duty to act in the best interests of all the creditors.
Decision
The court held that the charge over the IP addresses was a floating charge rather than a fixed charge.
Analysis of the charging clause
Firstly, the court had to determine whether IP addresses fell within the fixed charge over “all licences, consents and authorisations” by analysing the charging clause in the Debenture. The Lender argued that the word “authorisations” (which caught registrations pursuant to the Debenture) included the IP addresses as a registration at the internet registry that had issued them. The judge accepted that the natural and ordinary meaning of the language used in the Debenture was sufficient to include IP addresses, therefore evidencing an intention to create a fixed charge over that asset. This followed the approach taken in Avanti in that assets that were in their nature registrations were capable of being subject to a fixed charge.
Although the judge accepted that the lack of an express reference to IP addresses in the charging clause indicated an intention to create a floating charge from the outset, this point was not conclusive and in order to ascertain whether the charge was fixed or floating, consideration needed to be given to:
- The nature of the IP addresses to determine if they were capable of being subject to a fixed charge or only a floating charge, and
- The question of whether the Lender had the requisite level of control over the IP addresses to indicate that the charge was, indeed, a fixed charge.
Fixed or floating?
Nature of the IP addresses
The judge concluded that the IP addresses were not part of the Company’s “circulating capital” and were not ‘fluctuating assets’ which generally tend to indicate floating charges rather than fixed. However, although the IP addresses did not fall into these categories, the judge acknowledged that it did not automatically follow that the charge over them was fixed, and this point was therefore inconclusive.
The judge also held that individual charging clauses are “all or nothing”, meaning all assets that fall within a specific charging clause must be subject either to a fixed charge or a floating charge. There cannot be a mixture of fixed charges over some assets and floating charges over other assets within an individual charging clause.
Control
The judge then had to determine whether the Lender had exercised sufficient practical control over the IP addresses for the purposes of creating a fixed charge. The Lender did include control provisions in the Debenture but did not exercise such controls or seek to do so in practice. The judge found that post-contractual conduct is incredibly important when assessing whether a lender has a fixed charge. Simply including contractual provisions for control in the Debenture in isolation is unlikely to be enough to demonstrate the requisite level of control needed for a fixed charge. Following the decision in Avanti that “if a stipulation in the charging documents is not adhered to in practice, the agreement may be held to be a sham and characterised as a floating charge”, the control provisions in the Debenture were found to be a “sham”. In reaching this view, the judge found that the Company was at all times able to carry on its business and deal with the IP addresses without the consent of the Lender, and that therefore the charge was reclassified as a floating charge due to the lack of practical control by the Lender needed to demonstrate a fixed charge.
Key takeaways
This case will interest lenders, especially when they are considering how to structure/draft their security documents or looking to enforce their security.
Lenders, when taking security, should:
- Identify and check the chargor/company’s valuable assets to ensure they are not part of a chargor’s/company’s “circulating capital” or “fluctuating assets”,
- Charge each asset specifically (by name) rather than relying on generic charging clauses (like we had in this case). Careful and clear drafting is very important; and, most importantly,
- Control what happens to that basket!
In addition to simply getting the drafting right, following this case lenders should also take steps to ensure that they:
- Have the requisite levels of practical control over an asset in order to avoid a fixed charge being reclassified as a floating charge,
- Can demonstrate that sufficient control is actually being exercised over that asset.
As emphasised in this case, simply including control provisions in the security document will not help lenders if they do not enforce these provisions in practice. The court will take post-contractual conduct into account when making their determination, therefore lenders must be able to evidence that the necessary level of control is exercised and enforced in practice by monitoring whether a chargor/company is complying with its obligations in the security document and enforcing those contractual control provisions. Any absence of this control over the asset being exercised in practice means that lenders risk their fixed charges potentially being reclassified as floating charges which can have an adverse impact on their priority position and ultimately the amount of proceeds they are likely to receive when they are trying to enforce their security.
This case is a helpful and important reminder that as per the principles set out in the judgment in Spectrum Plus, the label used in a security document to describe the nature of the charge created over an asset is an indication to the security interest intended to be created, but it is not in itself conclusive. Even if the parties to the security document have described the charge as being fixed, if the requisite levels of practical control are not present, the court may well reclassify that charge as a floating charge. These principles (especially regarding the distinction between a fixed and floating charge), although fine-tuned by Avanti and this recent case of Re UKCloud Ltd, have not been overturned and remain in force.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, July 2024
